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Why Discover Financial Services Slipped 17% in January

Discover Financial Services gets a "decline" from investors following its fourth-quarter results. Find out if Wall Street is being short-sighted or if there are serious issues to be concerned with here.

What: Shares of Discover Financial Services(NYSE:DFS), one of the largest financial products and services companies in the world, slipped 17% in January, based on data from S&P Capital IQ, following a weaker than expected fourth-quarter earnings report.

So what: For the quarter, Discover Financial Services delivered net income of $404 million, or $0.87 per share, down about a third from the $602 million, or $1.23 per share reported in Q4 2013. Even adjusted for a handful of one-time and non-recurring expenses Discover Financial reported $1.19 in EPS, a clean $0.11 lower than what Wall Street had been forecasting for the credit giant.

There were a number of headwinds that weighed on Discover in Q4. For starters, lower gas prices pushed down the amount of revenue it generated. Higher prices lead to a bigger percentage of the pie for credit card companies like Discover. But, if consumers are spending less at the pump because gas prices have dropped it ultimately means less for Discover.

A jump in operating expenses and one-time charges was another culprit of Discover's mediocre results. The company's operating expenses romped higher by 10%, tied to a goodwill impairment related to its home loans platform. Increased marketing costs and rising employee compensation also contributed to the spike in expenses. Discover Financial also took a $178 million charge related to the elimination of its credit card rewards forfeiture reserve.

Combine rising expenses and one-time costs with worries about growth in Europe and you have the perfect recipe for a downtrend.

Now what: There's no sugarcoating it, this wasn't a great report. Then again, I'd have expected it to be a whole lot worse considering the 17% decline in the company's share price during January.

On the bright side total loans expanded by 6.4% to $4.2 billion and credit card loans, which carry meatier lending rates, rose 5.6% to $56.1 billion. Credit interest yields of nearly 12.1% were consistent with the prior-year period, meaning simply that if it can get its costs under control it'll deliver profit increases to investors by doing nothing more than increasing its outstanding credit loans.

In terms of credit quality Discover saw a slight uptick in its net principal charge-off rate and 90-day delinquency rate, but considering that much of the sector is running near historic lows for delinquencies I wouldn't allow this to worry you too much.

In reality, Discover's forward P/E of nine and its rising dividend yield, which is nearing 2%, are looking extremely attractive -- especially when you factor in the company's double-dip potential whereby it can earn money by serving as the transaction facilitator for the merchant and as the lender for the consumer. As long as the global economy doesn't tank to the extent we saw in 2008-2009, Discover should, in my opinion, hold up just fine.

Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of Discover Financial Services, Bank of America, and Apple. It also recommends Bank of America and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and investment planning. You'll often find him writing about Obamacare, marijuana, drug and device development, Social Security, taxes, retirement issues and general macroeconomic topics of interest. Follow @TMFUltraLong